Why the euro is undergoing a “fundamental adjustment”

A Euro currency symbol is displayed in the visitor center of the European Central Bank (ECB) building in Frankfurt, Germany.

Alex Klaus | Bloomberg | Getty Images

this EUR In the past month, with the comeback of Covid-19, European Central Bank policy divergence and political uncertainty converged, the stock market fell.

As of Tuesday morning in Europe, the euro is down 2.6% this month and 7.8% year-to-date. Dollar, And also weakened against other major currencies.

Germany, the Netherlands, and Austria re-implemented strict Covid-19 containment measures With the fourth wave of infections across the African continent, worries about the recovery of growth in the Eurozone have rekindled.

At the same time, the European Central Bank has maintained its dovish stance despite soaring inflation, and other central banks have indicated that interest rate hikes may slow down.

European Central Bank President Christina Lagarde said last week that the bank “will not rush to tighten prematurely when faced with past or supply-driven inflation shocks.”

The euro rose slightly on Tuesday, after the Eurozone Purchasing Managers Index in November showed an unexpected rebound in business activity, which once again hinted that the European Central Bank might tighten its policy before the end of 2022.

Zach Pandl, Co-Head of Forex Strategy Goldman Sachs, Said in a report on Friday that given the higher-than-expected U.S. inflation report in October, the recent weakness of the euro against the dollar can be largely attributed to the expected change in Fed policy

“To some extent, these risks now seem to have been digested: the comments made by Fed Governor Waller and Vice Chairman Clarida on Friday that the Federal Open Market Committee may accelerate the pace of quantitative easing have limited impact on the euro/dollar. “He added.

The U.S. dollar index, which measures the U.S. dollar against a basket of major currencies, hit its highest level since July 2020 on Monday. But Pandel said that certain European factors, such as the new activity restrictions in mainland economies and the dovish attitude of the European Central Bank, may explain the euro’s weakness against the broader currency cross.

Goldman Sachs holds short positions in the euro against Swedish krona, Polish zloty and Czech koruna. Shorting a currency indicates that the trader believes that it will depreciate relative to the other side of the currency pair over a period of time.

The trade balance is neglected

In its latest foreign exchange position analysis, BMO Capital Market Emphasize that leveraged funds have been cutting long bets on the U.S. dollar in various currencies, and the U.S. dollar has appreciated by 7.2% year-to-date DXY Dollar Index As of Monday’s close.

However, the euro-dollar cross is one of the few that saw an increase in US dollar bulls in the week ending November 16. The net short position of EUR/USD increased from USD 5.1 billion in the previous week to USD 5.7 billion, while the direct EUR short position increased by nearly 11,000 contracts with a total value of USD 14.3 billion.

“Our view is that the euro is undergoing a fundamental adjustment, which is not only related to expectations of policy differences between the European Central Bank and other central banks, new COVID-19 restrictions in some EU member states, and moderate to high political risks,” BMO Europe Stephen Gallo, head of foreign exchange strategy, said in a research report on Monday.

“Although these factors are important, we have listed the deterioration of the euro zone’s trade balance in the third quarter as one of the most important drivers of euro weakness, which continued to weigh on the euro in the fourth quarter.”

Gallo emphasized that as of Friday’s close, the narrow measure of the nominal value of the euro — its unadjusted weighted average relative to other major currencies — fell by 1.2% in the third quarter and has fallen further so far in the fourth quarter. 2.5%.

According to data from Eurostat, the merchandise trade surplus between the Eurozone and the rest of the world in August 2021 was 4.8 billion euros, compared with 14 billion euros in August 2020. In September 2021, the total trade surplus narrowed from 24.1 billion euros to 7.3 billion euros in the same month of 2020.

“A separate but interrelated issue is that the euro also needs to embed a mid-term’energy security risk discount’ in the price,” Gallo said.

“In the short term, the downward oil price will become a buffer below the euro, but we believe that a large number of negative fundamentals may mask the positive impact of the decline in oil prices.”

Although some of the cyclical factors affecting net trade may fade in the next two years, Gallo believes that structural changes involving “de-globalization” forces and efforts to achieve carbon neutrality mean that the euro area’s export growth may not be as As positive as it used to be in the past two decades.

“Looking forward to the end of the year, the position of the euro against the dollar may inhibit the downward momentum,” Gallo concluded.

“We will also point out that the extent of the Fed’s rate hike has been reflected in the USD curve in 2023. This is a potential upside risk for the euro against the U.S. dollar. If anything will cause these rate hikes to be cancelled.”

BMO’s current one- to three-month range for the euro is estimated at $1.11-1.16.

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